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Abby of Dear Abby, passed away last week. I don’t intend to take her place dispensing relationship advice, but I do get my share of Dear Dave letters. Here’s a Dear Dave inquiry I had last month:

Dear Dave,

We have a problem. Our ranch manager is a family member but does not have equity in the ranch. This year, because of the drought, we received a government crop insurance payment and we made a big profit. The manager says we got the payment and therefore the profit, due to his skill in applying for the insurance program. In addition to his annual salary of $60,000, he is demanding a 5% annual profit share. Is this fair?

Please advise,Want To Be Fair

Dear Want To Be Fair,

So he wants a share of the profit. Would your business have made a profit had there not been a drought or are you hoping for a drought every year? If you make a loss will he expect you to take a portion of the loss out of his paycheck? I don’t know what people in your area are getting paid, but in my opinion, a ranch manager paid $60k/year, isn’t in much of a position to “demand” anything. That’s pretty good compensation relative to what other managers get…and I don’t respond well to “demands.” If the demands persist, politely listen, then show him the door and wish him luck finding work in this economy. On the other hand if the employee approached me with concerns about their compensation I’d listen to understand their concerns and make every effort to work out a fair arrangement.

Sincerely,Dave

This letter underscores the importance of having a formal written policy about employing family members. Family members ought to be held to the same standard you would use to hire non-family employees. But the more immediate issue in the letter has to do with compensation so I told Want To Be Fair that there are three possible elements to a compensation plan:

Salary and Benefits: pay for the work

People need to be paid enough so that they focus on work, not on how they are going to put food on the table for their family. Beyond that, money isn’t very motivating. To reinforce that point, check out this video:

Employees may not recognize the value of benefits they receive. I recommend making a list of all of the perks (vehicle, housing, side of beef, hunting, etc.) that each person gets. Document the value of each of those things. This will make the true value of the compensation package clear.

Bonus: reward achievement

Bonuses reward employees for their achievement. If you choose to use a bonus, make sure that it is tied to achievement of individual goals and team goals. Set a minimum target that has to be achieved for the bonus to kick in. After all, people ought to be expected to produce some minimum result. They should not get a bonus for ordinary performance.

As a rule of thumb, if you set the bar high, make the bonus big. Whatever the bonus is based on (e.g. profit, gross margin), you need to be perfectly clear on how it is going to be measured, e.g. cash profit or economic (accrual) profit. As you saw in the video linked in the salary section, money is not an effective motivator, so when bonuses work (and they often backfire) it’s not the money as much as the recognition for achievement that the money represents that makes it work.

At RMC we don’t pay a monetary bonus. Instead we will buy a gift (usually a gift certificate to an employee’s favorite restaurant) to recognize special achievement. We also pay a profit share. If the company does well, we like to share the success with the people who helped create it, whether they had a direct hand in it or not. The profit share is not used as a tool to motivate our staff. Instead we use it to reinforce that we are all part of the RMC team.

Growth participation: For someone who is going to contribute to the long term growth of the company you may want to reward them with an equity position. Giving someone “Phantom Shares” gives them an equity position with the written agreement that when employment is terminated the shares will be purchased back by the company. If the company is worth $5,000,000 and under my management it grows to $7,000,000 million, I’d get a percentage of the $2,000,000 of growth to which I contributed. Let’s say part of my compensation is 5% share of the growth. If I leave after my 10 years you’d have to buy me out for $100K (5% of the $2 million I helped create). You’d need to make sure you had an independent, objective appraisal when the program starts and ends. You’d also better make sure your assets are liquid enough to raise the money to buy me out.

A growth participation program tends to keep good people around longer but also makes it harder to get rid of someone should things turn south. That’s why before you do something like this you need to be pretty darn sure you have the right person. I recommend using a vesting period of at least 3 years. This is a good way to build some kind of retirement program for long term employees…but again, you need to be able to buy them out when they leave.

Regardless of the compensation package, you need to determine what other competent managers are paid for similar responsibilities in the area. Check with your local extension folks to see if they have data on salaries for people doing similar work in your region. I suggest that you share that information with the employee. Then you’d need to set some objective criteria to define competence, and measure their performance relative to those standards regularly (e.g. semi-annually). Someone needs to do a performance review, or things will get out of control.

I ended my letter to Want To Be Fair suggesting that while the manager is demanding more money, there may be a deeper issue. I wonder if he is really demanding respect or appreciation. Stan Parsons once told me, “You can buy someone’s hands, but you can’t buy their mind, and that’s where their creativity comes from. Nor can you buy their heart, and that’s where their loyalty comes from.” Paying more for his hands doesn’t mean you’ll get his mind or heart.